This opinion piece was also published in El Economista, Le Monde and Der Spiegel.
After years of despondency, there is new and positive momentum in Europe. With the French electing Emmanuel Macron and a broad recovery in the euro area, leaders in Brussels and national capitals have an opportunity to push ahead with long-needed reforms. Simultaneously, the calamities occurring in British and US politics serve as a useful reminder that “we Europeans must really take our destiny into our own hands”, as the German chancellor Angela Merkel recently put it.
Nevertheless, these moments of opportunity can be short and priorities must be set. We consider it essential to focus on three pillars of reform in the coming months: completing a robust euro area; building a coherent EU foreign policy; and harnessing the single market’s potential to deliver strong and inclusive growth.
First pillar: a strong Euro for good times and bad
While the euro area is finally witnessing a decent economic recovery, it would be wrong to be complacent. The single currency remains vulnerable in its institutional architecture, and faces many unresolved problems at the national level.
First and foremost, national policy action must continue to focus on tackling imbalances and fragilities that can undermine the Euro. For example, the Banco Popular case in Spain has shown that the EU’s bail-in framework can work when efficiently implemented. Now banking problems elsewhere should be rapidly addressed, as these issues in the financial sector are a burden on growth. Weak productivity, a lack of innovation and underinvestment are also creating serious imbalances, and they deserving clear structural and fiscal policy action from national governments.
But it is equally important to complete the institutional architecture of the euro area. This does not mean that the euro area should become a full federation, and certainly not a totally centralised state. That is not about to happen. However, the original set-up in the Maastricht treaty has proven unsustainable and unstable. A common monetary policy without any common macroeconomic strategy (beyond the country-by-country rules of the Stability and Growth Pact and the loose European semester), has proved inadequate to avoid a prolong period of very low growth and inflation. There is a middle ground between full “political union” and the shaky Maastricht model. This is the only option the euro area can and should pursue.
Euro area partners should explore this middle ground and begin work on concrete projects. One obvious priority is the incomplete banking union. We must move forward on risk reduction and risk sharing in the euro-area banking sector. On the one hand, this means limiting and diversifying the sovereign debt on banks’ balance sheets to break the toxic loop between banks and governments. On the other hand, it means building a significant common fiscal backstop, for example by establishing a “European Monetary Fund” based on the current ESM. France and Germany are still divided over the sequencing of the different steps, including whether or not we need some form of “safe asset”. This debate should be resolved as quickly as possible, because completing banking union is urgent for the stability of the euro area.
Another key project for the euro area is meaningful capital market integration. Deeper cross-border capital markets are essential for risk absorption in the euro area and long-term convergence between countries. So far the European Commission’s proposals have been uninspiring. But Brexit has increased the need to move forward with an ambitious agenda, including common supervision of markets.
A final urgent question for the euro area is how to repair its discredited fiscal framework. Here some of the issues are extremely controversial. For example, we doubt that divisions between France and Germany on a fiscal stance for the euro area can be easily overcome. Nevertheless, a stronger European banking union, which finally breaks the vicious circle between banks and sovereigns, will allow progress on the thorny issue of unsustainable public debt. The reason is that it will reduce the collateral damage of a sovereign default, and therefore the need for bailouts.
German concerns about bailouts and the moral hazard they generate are valid. They should be answered by stronger national responsibility for unsustainable debt. The more one accepts this logic, the less intrusive the European fiscal framework can become, as countries will have to bear the consequences of their own poor fiscal planning. However, greater fiscal responsibility at national level (with the possibility of default) should come hand in hand with some form of support at the euro-area level. This could be, for example, a Eurozone budget for additional investments such as infrastructure networks. As a matter of fact, the path towards more responsibility with respect to national sovereign debts needs to be carefully monitored to avoid triggering new accidents.
Second pillar: a European foreign policy
Dreams of a European foreign policy have been around for years, but global geopolitics is in a period of upheaval and Europe must find a way to respond. We believe that the EU needs deep reform to be able to react adequately to the challenges at hand with a new spirit of close cooperation. These include managing the dramatic influx of refugees, creating a common migration policy, and forging a more efficient and comprehensive system for border control and security. Further afield, Europe faces a difficult US that is tempted by protectionism and free-riding on climate, while China and other emerging economies are using their economic development to assert themselves in trade, investment and governance. It is time for a re-think of the EU’s foreign policy strategy, and we see two priorities.
First, the EU needs to repair its credibility on trade and investment negotiations, which was severely damaged by the difficulties in ratifying the deal with Canada. Trade and investment deals should be negotiated and agreed by the EU as a bloc. But the EU should not be naïve when faced with more aggressive trade policies worldwide. Europe should make robust use of its competition policy framework against foreign state-owned enterprises who enter our markets, and find ways to monitor and control foreign direct investment in sectors that are of strategic interest. Individual states lack the tools and weight to manage these challenges alone, so on trade and investment the only efficient solution is the European one.
Second, the EU needs to upgrade its strategic capacity to intervene abroad and defend itself. We therefore welcome the initiative to move ahead on defence collaboration. Progress on joint procurement could enhance the efficiency of EU military spending and joint EU research can also help in this regard. Common defence spending is also the kind of concrete political and fiscal project that can strengthen the euro zone. At the same time, we would caution against any belief that NATO can or even should be replaced at short notice.
Third pillar: harnessing the (digital) single market for inclusive growth
GDP and productivity growth have been disappointing in many EU member states for some time. But the single market is far from complete, and there are still large gains to be reaped from integration among the 27 EU member states. In particular, several service sectors are still loosely integrated and digital technologies can break down economic borders. However, we must remember that economic integration raises productivity and average welfare through a “creative destruction” process which also generates losers. Those citizens who feel that they are losing out will rationally oppose any leaps forward in European integration unless they are properly supported and compensated.
Therefore, tax and social cooperation both need to be upgraded so that member states are empowered to implement policies that mitigate the pain of economic integration. These could include a common European tax base to discourage profit-shifting, an ambitious strategy against tax evasion, promotion of dual vocational training and a modern strategy against social fraud to support displaced workers. In our view, these strategies should above all focus on skills and mobility for European workers.
Time to act
At long last Europe has a moment of opportunity. But it should not be wasted on theoretical arguments about the “end goal” of European integration. The EU will remain an entity sui generis, neither a full federation nor just a loose cooperation of states. Leaders should not miss this chance for a systematic overhaul, but they must also push ahead with concrete projects that deliver for European citizens. An open and serious debate about all options is needed; then it is high time to act. If we do, the chances for a stronger Europe are better than they have been for a long time.